7 Steps to Build a Diversified Value Portfolio from Scratch

Laying the Groundwork for a Winning Value Portfolio

A well functioning highly performing value portfolio takes time and effort to built. It may seem daunting at first, but you can create processes and structures that will make the portfolio building and maintenance almost effortless.

Here I lay out the ground work for a winning value portfolio, based on my 25+ years of value investing for myself and for my clients. You are free to use and adapt parts of this process to suit your own investment philosophy.

This process will ensure you choose high-quality undervalued stocks, manage risk, and have a solid approach to entry in and exit out of a position. Here are the main steps:

1. Screening for Potentials
2. Maintaining Watchlists
3. Researching the Potentials
4. Portfolio Allocation, a recap of various strategies you can use
5. Stock Entry Strategy
6. Stock Exit Strategy
7. Rebalancing

Let’s take a look at each of these steps now.

Step 1: Screening – Identifying Value Opportunities

Before you invest, you need a method to separate the wheat from the chaff. Screening helps you filter through thousands of stocks to find those that meet your value investing criteria. I have my trusted set of screeners that I regularly use to build a shortlist of stocks I should be looking at.

Key Screening Metrics:

• Low Price-to-Earnings (P/E) and Price-to-Book (P/B) Ratios – Indicators of undervaluation.
• Strong Free Cash Flow (FCF) – Ensures the company isn’t reliant on external financing.
• High Return on Invested Capital (ROIC) – Demonstrates management’s ability to allocate capital efficiently.
• Low Debt-to-Equity Ratio – Reduces financial risk.
• Consistent Earnings Growth – Avoids value traps with deteriorating fundamentals.
• Discount to Intrinsic Value – Calculated using discounted cash flow (DCF) or earnings power analysis.
• Consider other metrics such as Graham Number, Dividend Yield, PEG Ratio, Piotroski F-Score, etc.

Screening Tools:

• Stock Rover, Finviz, or Value Line – Platforms that help filter stocks based on key criteria. I have used Stock Rover for 5+ years now and I can confidently say that it will support ALL of your needs for screening, research, portfolio management, tracking and rebalancing. In short, everything you need to do as a value investor, and all steps of the process I am outlining here in this article, you can do using Stock Rover (and your brokerage account).
• Company Filings (10-K, 10-Q) – For deep dives beyond screening tools. These are extremely important to learn about strategic and tactical aspects of the business, management thinking, competitive landscape, etc, along with the obvious earnings performance of the company.

Once you’ve identified a list of potential stocks, the next step is refining your choices.

Step 2: Watchlist – Narrowing Down the Candidates

Your screening process will generate a long list of stocks, but not all of them will be true investment opportunities. The watchlist phase helps you focus on the best candidates before committing capital.

In Stock Rover, I can build 1 or more watchlists. It is upto you to decide how many watchlists you want and for what purpose. For example, you can have a single watchlist for Potential Value Stocks, or you can have multiple watchlists that you break down by strategy or industry or dividend paying or not, etc. Every time I run a screener, I review each stock that it returns and make a decision of whether a stock is worthy of further research or not. If I decide to shortlist a stock for more research, it goes into my watchlist(s).

How to Build a Strong Watchlist:

You need to approach the building of the watchlist with a different expectation than when you are looking for find a stock to invest in. Remember, you are looking for stocks to do due-diligence in. You do not want to remove too many stocks from your shortlist. Most good undervalued stocks are not obvious on the surface – they require deeper analysis to recognize that there is a value. If you remove the stocks too early in the process, you may not find too many great investment opportunities.

Instead of looking for stocks to add to the shortlist, look for stocks that are obviously not good fits, and eliminate them. For example, suppose one of your investment criteria is low level of debt. You can review the screener results and eliminate the stocks that have high debt, say a debt/equity ration about 0.8, from your consideration. Once all the stocks that obviously do not qualify based on your investment criteria are disregarded, what remains goes into your watchlist.

You may want to:

1. Verify Financial Strength – Deep dive into balance sheets, income statements, and cash flow statements.
2. Assess Business Quality – Is it a market leader with a competitive moat?
3. Analyze Management and Governance – Are executives aligned with shareholders?
4. Look for a Catalyst – Is there a reason the stock will re-rate higher? (Earnings growth, turnaround, buyback plans, activist investor involvement, etc.)
5. Assess Market Sentiment – Look at historical trading patterns, insider buying, and institutional ownership.

A well-crafted watchlist ensures that you only commit capital when the risk-reward profile is in your favor. Just remember, this is your first level research and you are not making a buy or sell decision at this point. You are only making a call whether you would like to spend a few hours or days into researching this stock at a deeper level.

Step 3: Research – Deep Dive Before You Buy

Screening and watchlists are just the beginning. Once you’ve identified potential stocks, it’s time to conduct rigorous research. Go into this with the expectation that you will spend a few hours at the minimum with each stock. You may end up spending a few days for some, and maybe even longer for a few that show great promise. At this point every hour spent in due-diligence is worth it – it will either make you a lot of money, or it will save you from losing a lot of money.

You will conduct fundamental analysis and review many different aspects of the business. This will help you collect data, peer comparisons, estimates, etc that you will use to determine the valuation of the business.

Fundamental Analysis:

Every business is different and you will ask different questions of it. However, at the minimum, pay attention to the following key aspects. This will help you identify quality businesses and also determine if the undervaluation, if it exists, could be temporary.

• Competitive Advantage (Moat) – Does the company have pricing power, a brand, or a network effect?
• Industry and Macro Trends – Are external factors favorable? Any regulatory concerns?
• Management Strategy – Does leadership have a solid track record? Do they have a well articulated strategy that actually makes sense? Are they taking actions that are aligned with the picture they are projecting? For example, it would be disconcerting if the management is painting a very rosy picture and at the same time there has been a trend of insider selling.
• Cyclical vs. Non-Cyclical – Does the company’s performance depend on the economic cycle? If it does, where are we in this cycle and do we see the cycle turning soon?

Valuation Techniques:

Every value investor has their own favorite ways of valuing companies. If you have one, by all means use it. But also be aware of other possible ways of estimating the intrinsic value of the stock.

• Discounted Cash Flow (DCF) – Estimates intrinsic value based on future cash flows. Most investors swear by this as technically precise. I find this problematic as it is practically wrong in almost all cases. Whenever you depend on future estimates of earnings for the next 10 years, discount rates, a poorly defined terminal value, a guessed growth rate, and an assumption of the competitive environment in the future for the company, I would say there is a disproportionately high change that you will be wrong, and likely by a large margin.
• Earnings Power Value (EPV) – Looks at normalized earnings over time. Much better than the DCF analysis, this is based on the evidence of the execution the company has already demonstrated.
• Comparable Company Analysis – Benchmarks valuation against peers.
• Graham Number – Utilize a blend of P/E and P/B ratio to find stocks that may be undervalued.
• Liquidation Analysis – Assuming the business closes shop immediately and has an orderly liquidation of the asset. What is it all worth in this situation? This tends to be your worst case scenario, but you will be amazed how many times you find stock that are selling at even cheaper valuation.

Normally you will find yourself using a variety of valuation techniques to fit the situation.

Step 4: Portfolio Allocation – Maximizing Returns, Minimizing Risk

Even the best stock picks won’t deliver optimal results without a proper allocation strategy. There are multiple ways to structure a value portfolio, but the key is balancing risk and reward. I list a few possible models you can utilize.

Portfolio Allocation Models:

• Kelly Criterion – Maximizes long-term capital growth by adjusting position sizes based on expected returns and risk. Kelly Criterion is mathematically show to generate most optimal long term performance, but it is hard to do as it requires you to understand your edge and be confident in your calculations of expected returns. I use this model.
• Risk Parity – Allocates based on volatility, ensuring no single asset dominates risk exposure. This is a great way to equalize volatility across your portfolio.
• Equal Weighting – Simplifies allocation, avoiding over-concentration in any one position. This also simplifies rebalancing as you can tell just by looking which stocks have become over allocated and which stocks are under allocated.
• Conviction-Based Sizing – Invest more in high-conviction ideas, less in speculative bets. This is a more intuitive form of Kelly Criterion.

Your allocation strategy determines how resilient your portfolio is during market turbulence.

Step 5: Entry Strategy – Timing Your Buys

Buying a stock at a great price is just as important as selecting the right stock. Your due diligence will tell you the intrinsic value and the margin of safety at the current prices. Your allocation model will tell you how much of the stock to purchase. Once you have decided to buy a stock, you need to figure out a process of establishing a position.

Entry Tactics:

• Limit Orders Only – Avoid market orders to prevent overpaying, especially for small-cap value stocks. Long term limit orders (GTC) will help you get into a position over time even when the stock is very illiquid.
• Buying in Tranches – Enter a position in multiple steps rather than all at once. Most value investors tend to be early on the buy, the stock usually becomes cheaper after their purchase, before it turns around. Buying in tranches will help you get the additional discount in the stock price.
• Wait for a Pullback – Use technical levels like support zones to optimize entry points. I am not very good at technicals, but if you are, certainly consider this.
• Use Market Sentiment to Your Advantage – Buy when there’s fear and pessimism.

Having a disciplined entry strategy can significantly enhance long-term returns.

Step 6: Exit Strategy – When to Sell

Knowing when to exit a position is just as crucial as knowing when to buy. If you have done your research well, you know the fair price of the stock. This tells you the approximate price to sell the stock to gain maximum profit. There are other reasons to sell a stock, a few of these are listed below.

Sell Criteria:

• Price Reaches Intrinsic Value – If a stock hits your target price, it’s time to cash out. Before you do this, you may want to take a 2nd look at the intrinsic value and make sure it has not gone up since you last checked.
• Fundamentals Deteriorate – If earnings decline, debt spikes, or management makes poor decisions, reconsider holding.
• Better Opportunities Arise – Rotate capital into higher-return opportunities. This is automatically handled if you use the Kelly Criterion for portfolio allocation.
• Overvaluation by Market – If hype drives the price far beyond fair value, take profits. It is natural to get carried away by the hype. Just remember, you are not leaving profits on the table by selling, you are freeing up your capital to invest in more profitable opportunities (and perhaps avoiding a stock price crash)
• Tax Considerations – Optimize exits to minimize tax liability where applicable.

Selling should be a rational decision, not an emotional one.

Step 7: Rebalancing – Keeping Your Portfolio in Check

Once you’ve built a value portfolio, the work isn’t done. Regular rebalancing ensures your portfolio stays aligned with your strategy.

There is a lively debate among the two camps of investors – one camp suggests that you should let your winners ride, while the other camp suggests you should take profits when you can. Rebalancing is your way to taking advantage of both these ideas at the same time.

Consider this. When you rebalance, you are shaving a little off the top of the stock that has risen (taking profits) and investing in the stock that has fallen (buying at a discount). All the while, your core position stays intact in each stock, so you are letting them ride. Rebalancing is a way of incrementally buying low and selling high, on a repeat, and this adds what is called a “rebalancing bonus” to your portfolio. Rebalancing bonus is an additional alpha to your core portfolio return.

When and How to Rebalance:

• Quarterly or Annual Reassessment – Adjust allocations based on changes in intrinsic value and risk.
• Let Winners Run – But Within Limits – If a stock continues to outperform, consider trimming rather than fully exiting.
• Reinvesting Dividends – Deploy dividends into the most undervalued opportunities.
• Adjust for Macro Changes – If the economic environment shifts, adapt accordingly.

Rebalancing prevents concentration risk and keeps your portfolio performing optimally.

Final Thoughts: Building a Portfolio That Stands the Test of Time

Constructing a diversified value portfolio from scratch requires discipline, patience, and a solid framework. By following a structured approach—screening, watchlisting, researching, strategically allocating, and actively managing—you position yourself to outperform over the long run. Value investing isn’t about chasing the latest trend; it’s about buying great businesses at great prices and letting time do the heavy lifting.

Stay disciplined, stick to your process, and let compounding work its magic.